Fed Loses Patience, Stocks Soar - Alaska Permanent Capital Management


Fed Loses Patience, Stocks Soar

This week was pretty much all about the Fed. One could make the argument that for investors it has been that way for the better part of six years, but this week it was clearly the case. More specifically there was a lot of attention directed at the word “patient” and whether or not the FOMC would keep it in its statement. But before we get into all that, let’s first recall just how the Fed got itself into this semantic tango where markets hinge on every word it says.

At the end of 2008 the economy was imploding; the stock market was gyrating 5% in a day and the U.S. was losing 700,000 jobs per month. In December 2008 in an effort to stabilize the economy, the Fed cut its primary monetary policy tool, the federal funds rate, to zero (technically a range from 0-0.25%, but close enough) and it has been there ever since. In 2009, with the economy still continuing to struggle and the federal funds rate at a floor, the Fed needed additional ways to calm the markets and came up with the idea of forward rate guidance. As a result the FOMC inserted language into its statement that suggested given the current economic conditions the federal funds rate was likely to remain “exceptionally low” for a “considerable period.” In some form or another, the Fed kept that language in its FOMC statement for almost six years.

Fast forward to the end of 2014 and at its December meeting the FOMC amended the idea of a considerable or extended period with a statement that it would be “patient in beginning to normalize the stance of monetary policy.” At the time when it first appeared, the language of “patience” was widely interpreted as a transitional phrase which upon its removal would suggest that a rate hike was likely a couple of meetings away. The phrase was in fact removed from the statement released on Wednesday, and the Fed went on to explicitly state that a rate increase was “unlikely at the April FOMC meeting.”

However, along with the statement the Fed released its latest round of economic projections which saw marked reductions in expected GDP growth and inflation. The Fed has long said that any rate hike must be supported by fundamental economic data. Therefore in reaction to these lower economic forecasts investors looked past the removal of “patient” and pushed back expectations for a rate hike further into the second half of this year. Everyone knows that patience is a virtue and while the Fed may no longer have it, Chair Yellen and the FOMC want to see more improvement in the labor market and healthier inflation numbers before reducing the current level of accommodative monetary policy. As a result, the punch bowl of Fed supplied liquidity got a refill this week and the party in the stock market resumed.

Stocks skyrocketed with the Fed announcement on Wednesday as the S&P 500 gained over 2% in under an hour. After all was said and done for the week, the S&P 500 was up +2.7% from last Friday’s close. The Dow Jones Industrial Average lagged a bit with a five day gain of 2.1%, while the NASDAQ Composite surged 3.2% and closed just a half a percent away from its all-time high. As of the close on Friday, the S&P 500 is now up 0.3% for the month of March and 2.9% since the start of the year.

In regards to bonds, Treasuries got a boost from the Fed’s lowered growth and inflation expectations. All parts of the curve saw declines in yield this week (and increases in price), as maturities of a year or less lost around 2 basis points while bonds from three to thirty years dropped between 13 and 20 basis points. The ten year Treasury now yields 1.93% while the 30 year long bond offers 2.51%.

U.S. stocks may have gotten a bit of a boost from the Fed’s actions this week, but shares in Europe saw even bigger gains thanks mostly to the euro finding some traction against the dollar. The common currency was up more than three percent this week as it rallied from a 12 year low reached last Friday. While there was some potentially good news out of the whole Greece debacle that added to the gains, most of it can again be attributed to the actions of the Fed; the longer the Fed waits to raise rates, the less appealing U.S. dollars become. The broad European STOXX 600 Index rose 5.4% this week and is up a staggering 18.7% YTD when priced in euros. Gains in dollars are a bit more modest, but still impressive at 2.0% for the week and 6.4% in 2015. Also, in London equities kept calm and rallied on as the FTSE 100 Index closed above the 7,000 level for the first time ever.

Not to be left out, shares in Asia also saw healthy gains this week. Chinese A shares in the Shanghai Composite were up over 8% when priced in dollars as the index closed at its highest level since 2008. Equity markets in Japan, Hong Kong, Taiwan, and South Korea all saw gains of at least 2.5%, thanks in part to a falling dollar. All in all global equities were up 3.2% this past week as measured by the MSCI All Country World Index.

Possibly the most innovative and successful company ever had a very archaic financial honor bestowed upon it this week as Apple was added to the Dow Jones Industrial Average. The iPhone maker replaced long time member AT&T, which is a bit ironic as Ma Bell was the original and exclusive carrier of the device that has led to the bulk of Apple’s success. The honor is antiquated though because despite the widespread popularity of the Dow, it is not a very good index and hated by many in the investment management world. The Dow is often used as a gauge for the broader U.S. equity market, but there are two problems with this. First off, the index only has 30 members and while they may be well known (like NIKE, Wal-Mart, and J.P. Morgan) the U.S. economy is not well represented by such a small sample. Second, and a much bigger flaw, is that the index is weighted by price instead of size or market capitalization. That means that despite the fact the a company’s share price has absolutely nothing to do with how good of an investment it is, companies with higher share prices will be weighted more in the Dow. As a result, new member Apple, the largest company in the world and one that made $39 billion last year has a smaller weight in the index than Goldman Sachs, 3M, IBM and Boeing.

With all of the hubbub about the Fed’s expectations for the economy this week, we also had some news on its accounting. More specifically how much money it made last year. When you have a balance sheet of $4 trillion dollars of U.S. government bonds you end up generating a lot of interest income. In the case of the Fed that amounted to $115.9 billion in 2014. By law the Fed is required to hand most of that over to the U.S. Treasury, i.e. return the interest to where it came from.

And finally, today – March 20, 2015 – is the first day of SPRING. That means that today is one of two days per year when then plane of the earth’s equator passes through the center of the sun. As a result everyone on earth, from our friends up in Barrow to the folks down under in Sydney, has roughly equal amounts of daytime and night. While it is generally optimistic to starting thinking about spring for Anchorage in mid-march, it is currently sunny and 47 degrees and there is not a speck of snow to be found anywhere downtown. This season Anchorage has only seen 21 inches of snow, which is almost four feet below normal. The forecast calls for highs in the mid 40’s through next week, so if that holds this could just be one for the record books. Anchorage’s lowest snowfall for a season on record was in 1957-58 with just 30.4 inches (or nine more than this year). Then again, it could snow two feet in April. Sometimes with the weather, as with markets, you just never know.

Nicholas Case
Senior Investment Analyst


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